Europe Needs Action Not Words From The Greek Finance Minister

“Today our biggest deficit is that of credibility.In the last years Greece lost all traces of credibility, which is why international institutions, partners want to see actions.” Greek Prime Minister George Papandreou

As the Economist points out, and as I personally can confirm (since I am constantly having to alter and update my excel sheets), Greek government statistics are notoriously unreliable - indeed, I would say that along with the Bulgarians the Greek statistical agencies are the joint worst in the entire EU. But rarely can the numbers have seemed more erratic and subject to such sharp revisions as they have been in recent months. Following the election of the new government in October (who obviously decided to get as much of the bad news out of the way as quickly as possible) we suddenly learnt that far from having been being "spared" the worst of the global economic contraction, the Greek economy in fact entered a period of negative growth in the first quarter of 2009 (shrinking by 0.5% on the quarter instead of growing by 0.3% as the stats office had previously "estimated") wherein it is has subsequently remained. And of course given the size of the correction the Greek economy is now entering it is likely the economy will stay in this mode for some considerable time to come. And as if that wasn't shocking enough, the forecast for this year’s budget deficit more than doubled overnight, from 6% to 12.7% of GDP.

But this problem has a history, and quite a long one. The 2008 general government deficit as notified by the Greek authorities on 21 October to the EU Commission was put at 7.75% of GDP (up by 2.75% percentage points from the earlier estimate of 5% sent in April). But even this version was found to be deficient, and Eurostat specifically expressed reservations about the figures, largely due to the inclusion of a one-off capital expenditure item of around 1.25 percentage points of GDP mainly connected with public hospitals arrears to paramedical and pharmaceutical suppliers.

Moving forward, the official public deficit estimate for 2009 stands at 12.75% of GDP, as compared with the agreed budgetary target of 3.7% of GDP included in the January 2009 update of the EU stability programme. The EU Commission also estimate (in their November forecast) that under a no-policy-change scenario assumption and on the back of the discontinuation of the one-off expenditure item which has in fact been repeated in 2009, the headline deficit is set to remain above 12% of GDP in 2010 and then to continue to increase, exceeding 12.75% of GDP by 2011.

Both falling revenue-to-GDP and rising expenditure-to-GDP ratios will contribute to the anticipated fiscal deterioration. The economic downturn, coupled with high budget deficits, is expected to push debt higher, from 113% of GDP in 2009 to over 135% of GDP by 2011, thus weakening the already fragile sustainability of Greek public finances in the long term.

A Sorry History Of Repeated Failure To Comply

The timeline on this problem looks something like this:

i) On the basis of the data notified by the Greek authorities to the EU Commission in October 2008 the Commission, on 18 February 2009, adopted an Article 104(3) report for Greece on 18 February 2009. Subsequently, and in accordance with Article 104(4), the Economic and Financial Committee formulated an opinion on the Commission report on 27 February 2009.

ii) On 24 March 2009 the Commission, having taken into account its report under Article 104(3) and the opinion of the Economic and Financial Committee under Article 104(4), addressed to the Council, in accordance with Article 104(5), its opinion that an excessive deficit existed in Greece.

iii) On 27 April 2009, following a recommendation by the Commission, the Council decided, in accordance with Article 104(6) of the Treaty, that an excessive deficit existed in Greece in 2007 and 2008. At the same time, and in accordance with Article 104(7) the Council, addressed recommendations to Greece to put an end to the present excessive deficit situation by 2010, by bringing the general government deficit below 3% of GDP in a credible and sustainable manner.

The Council further recommended that the Greek authorities should

(i) strengthen the fiscal adjustment in 2009 through permanent measures, mainly on the expenditure side, including by implementing the measures already announced;

(ii) implement additional permanent measures in 2010, in order to bring the headline deficit clearly below the 3 % of GDP reference value by the end of the year;

(iii) continue efforts to control factors other than net borrowing, which contribute to the change in debt levels, with a view to ensuring that the government gross debt ratio diminishes sufficiently and approaches the reference value at a satisfactory pace; and

(iv) continue efforts to improve the collection and processing of statistical data and in particular general government data".

The Council established a deadline of 27 October 2009 for Greece to take effective action and to specify the measures deemed sufficient to ensure adequate progress towards the correction of the excessive deficit by 2010.

In support of its action the Council noted that a budgetary correction in Greece....

"is also crucial for recovering competitiveness losses and addressing the existing external imbalances. To this end, the Greek authorities should implement permanent measures, including the recently announced measures to control current primary expenditure, including public wages; and urgently implement structural reforms. In particular, the Greek authorities should ensure that fiscal consolidation measures are also geared towards enhancing the quality of public finances within the framework of a comprehensive reform programme, while strengthening the binding nature of its budgetary framework, improving monitoring of the budget execution and swiftly implementing policies to further reforming the tax administration".

That is to say, in depth reforms, and not simply cosmetics are called for.

Following their 11 November ruling the European Commission sent a large delegation of experts to Athens to assess the situation for themselves on the spot, amid strong rumours circulating Athens that the EU was not willing to approve the government's 2010 9.4% of GDP deficit first draft. In reponse to the evident EU reservations the Greek finance ministry circulated on November 20 what they called their revised "final" 2010 budget, with a projected deficit of 9.1% of GDP. But the patience of the EU had by that time become exhausted, and on November 30 2009 the Council of the European Union resolved Greece has not taken effective action in response to the Council Recommendation of 27 April 2009 within the period laid down in that Recommendation.

So we now move on to the next stage of the process, within which the Greek government will again be given a period of time (two months) to advance convincing measures, and another period of time (a minimum of four months and a maximum 16 months) to start to take the required measures (in 4 months) and give unequivocal evidence that they are credibly implementing them (within a maximum of 16, but my reading is that this process could be drawn to a close at any point before then if there were sufficient effidence that agreed steps were not being taken).

The relevant clause governing all this is to be found in Article Seven of the Council Regulation No 1467/97 of 7 July 1997, and runs as follows:

If a participating Member State fails to act in compliance with the successive decisions of the Council in accordance with Article 104(7) and (9) of the Treaty, the decision of the Council to impose sanctions, in accordance with Article 104(11), shall be taken as a rule within sixteen months of the reporting dates established in Article 4(2) and (3) of Regulation (EC) No 3605/93. In case Article 3(5) or 5(2) of this Regulation is applied, the sixteen-month deadline is amended accordingly. An expedited procedure shall be used in the case of a deliberately planned deficit which the Council decides is excessive.

If the country again fails to comply sanctions will be implemented, but my feeling is that this result would be the least important of the consequences. If the Greek government once again fails to live up to its reponsibility, then the internal disciplinary procedures of the Union will have failed, and my guess is Greece would be sent, cap in hand, over to Washington to ask for help from the IMF. If an IMF programme fails to work, well, let's leave that one for another day.......


Papandreou Fails To Convince

Evidently Greek politicians have come under continuous pressure in recent weeks, and Finance Minister George Papaconstantinou has been doing his best to convince the outside world that he means business. In a statement of intent issued at the end of last week he declared that "the fiscal priority for 2010 is a significant reduction of the deficit as a percentage of GDP and containing the increase in public debt which undermine the immediate and long term future of our country."

Prime Minister Pampandreou went further in a speech on Monday in which he spoke of his government's plans to cut the budget deficit from 12.7 per cent to 3 per cent of gross domestic product, the eurozone limit. Greece, he said, was “determined to send a strong message internationally: that we will move ahead with streamlining the economy and promoting a new model for growth.”

Fine words these, although the actual details available leave us far from clear about the precise nature of the deep seated reforms the Greek government is actually contemplating, or the extent to which they realise that significant wage and price deflation will be necessary if the are to restore competitiveness.

The decision to bring forward by several weeks the announcement of the government economic strategy underlines the new sense of urgency which now surrounds policymaking, and comes in response to a 10-day battering of Greek bonds and falling share prices on the Athens bourse. Yet it seems the investing community - the key players in the Greek democratic system now - remain unconvinced, since the yield on the Greek 10-year bond climbed on Tuesday morning 24 basis points to hit 5.70 percent, while the 30-year yield rose 15 basis points to 6.23 percent. Thus the extra yield, or spread, investors demand to hold 10-year Greek bonds instead of German bund equivalents widened 24 basis point to reach 253 basis points, the highest level since April 2.



Mr Papaconstantinou, has effectively been given the objective of reducing the deficit by 3.3% of GDP next year. The reduction is likely to come mainly from increasing revenues (asking businesses, for example, to pay a one-off extra 10% tax on last year’s profits) rather than from spending cuts, although this approach is unlikely to satisfy the Commission, who want long term structural shifts.

In an attempt to head off just this kind of pressure from the European Commission Mr Papaconstantinou has stated he will immediately tackle the structural reforms issue. Among ideas being currently touted are steadily raising the retirement age to 65 for women, opening up a range of “closed” services (from notaries to taxi drivers) to improve competitiveness and introducing five-year rolling budgets for ministries (to curb pre-election spending).

Yet despite the fact that Greek Prime Minister Papandreou promised on Monday that his government will, over the next three months, take all those decisions which "have not been taken for decades", plenty of grounds for scepticism still remain. Mr Papandreou's said many choices will be “painful,” though he pledged to protect poorer and middle-income Greeks. Unfortunately the speech was short on real detail, while the little we have is not impressive.

Talk about obtaining capital to reduce debt via securitization of income from the state’s tax on major property holdings sounds incredibly like simply taking some of the debt off the balance sheet to me, but I'm sure Eurostat will have their say when the time comes.

Whether the announced measures will be enough to satisfy the EU Commission remains unclear. In particular Mr Papandreou's reluctance to follow the example of Ireland, which announced a 4 billion euro correction of its 2010 budget with public sector salary cuts of five to 15%, has had a lukewarm reception from analysts and commentators alike. Greece faces mounting pressure from markets and its European partners to follow Ireland and adopt stronger fiscal measures such as a public sector pay freeze, a ban on civil service hiring and hikes in indirect taxes, to restore competitiveness as well as bring the deficit under control.

In a detailed and useful summary of the present Greek tragedy Kerin Hope and Ralph Atkins quote Yiannis Stournaras, a former chief economic adviser at the finance ministry and now a professor at Athens University as saying: “Wage cuts may not be needed, because the economy isn’t projected to shrink significantly next year, but there should be an immediate freeze on salaries and recruitment,”

I doubt the sort of measures we are hearing about will do that much to convince either Standard & Poor's or Moody's Investors Service, both of whom are currently considering cutting the Greek Sovereign rating. Moody's rates Greece at A1, well above the S&P level of A- (different classificatory systems) and seems willing to give the government time to address the situation.

But a cut by S&P, which is worried both about the amount of deficit reduction and how it is being achieved, would take their rating down into the triple-B category, where Fitch currently have it. ECB board member Lorenzo Bini Smaghi issued a scarcely veiled warning on Monday when he pointed out Greece had just one year to ensure it still had a single-A rating if it wanted its debt to qualify as collateral for central bank lending operations.

The whole discourse from the Greek political leadership gives us an indication of how far one discourse has moved away from the other. While Athens fiddles, the EU Commission continues to demand serious and sustained structural reform. I fear even the most recent of Greek governments only sees a short term problem of deficit reduction, and herein lies the danger, not only for the citizens of Greece themselves, but for all of us who live in the eurozone. This time the situation is for real, and I only wish I could believe that Mr Papaconstantinou and Mr Papandreou were aware of that fact. From this point on there is nowhere left to hide.

So What's It All About, Costas?

All the recent critical attention which has been directed towards Greece of late might seem surprising to some (or part of a global anti-PIGS conspiracy, to others) since, on the face of it, the Greek economy had managed over the last decade to appear to be something of a success story. Indeed the economy did clock-up a more than respectable growth rate, and the country even seemed to be well on the road to economic convergence with its richer neighbours, with GDP growing at an average annual rate of around 4.25% between 2000 and 2007, as compared with a 2% average for the euro area as a whole.



In particular there was a sharp acceleration in the growth rate in the early years of this century, stimulated in part by preparations for the Olympic games. As a result, living standards, measured in terms of GDP per capita in purchasing power standards (PPS), rose from 84.25% of the EU-27 average in 1997 to almost 95% in 2007. But as we all now know, and as many a Greek philosopher has often told us, "seeming" is not the same thing at all as being, and the current Greek case is no exception. Behind this wonderful facade, all was far from being as it should have been.

This was the case, not only in terms of the rather questionable data which was being sent out for external consumption - although, it should be noted, not everything was completely phoney, since Greeks today are surely much better off than they were in 2000 - but also in terms of a failure to explain how this rather spectacular change in fortune was achieved, or how the sustainability of the model on which it was based was to be ensured. As Titus Maccius Plautus reputedly put it, I am a rich man for just as long as I don't have to pay back my debts, and of debts in Greece there were plenty, especially in the public sector.

So the growth we saw in the first eight years of this century was hardly normal, since it was based on a model of growing indebtedness which was always going to fail one day or another. One consequence of this is that no one really knows what "trend" growth in Greece would look like at this point (the same goes for those other two Eurozone "star performers" Spain and Ireland) since we don't really know how much of recent growth was valid, and how much was due to overheating, and we won't really start to get a clear picture till we see what the downside is, and how far it runs.

In an earlier post I suggested that while Greek Sovereign Debt was far from dead at this point, in the long run it was almost surely dead. Here, and in the posts which follow I will try and explain why I think that is the case.

Twin Deficit Problem


Thus the very positive initial impression becomes rapidly tarnished when you start to think about the fact that, despite all the supercharged growth, the average Greek general government deficit remained over the EU Stability and Growth Pact 3% of GDP limit during the entire period (hitting a maximum of 7.5% of GDP in 2004, see chart below).

Given that the Stability and Growth Pact philosophy is effectively one having a 3% average target, with resources being accumulated during the good years to allow space for stimulus programmes which involve larger deficits during the bad ones, this state of affairs seems to be astonishing. The accident was just waiting to happen, since having overrun the allowance with growth which was over 2 percentage points above the average, there was no spare capacity left to be deployed during the downturn, Greece will now join a number of key East European economies - notably Hungary and Latvia - in being forced to impose a contractionary fiscal policy during what surely about to be the country's most serious economic downturn since the early 1980s. Ouch!

But in addition to this immediate, and acutely painful, problem, the consequences of all those years of excessive government spending have most definitely not been benign, and in this post, and those that follow I will focus on three of them.

i) The accumulating government stock of debt, which according to the last EU Commission forecast is set to reach 135% of GDP by 2011.



ii) The inflationary pressures to which the Greek economy was subjected by the decision to press the fiscal accelerator right down to the floor (hit the pedal to the metal) well beyond long term sustainable capacity, with the consequent loss of competitiveness this involved. Greek inflation was seldom above the EU 16 average during the critical years, and this neglect, of course does not come free.



In particular the loss of competitiveness with Germany is very evident.



(iii) The huge external deficit (current account deficit of 15% of GDP) which was the result of this massive overheating of domestic demand, and the large external debt which has been accumulated as a consequence. It is this external debt problem which makes Greece so vulnerable to financial crisis at this point, and it is this which differentiates the Greek case (and the Portuguese and Spanish ones) from, say the Italian one, since while in Italy government debt position is not that much better than the Greek one, most of the debt is actually held by Italians, and while Italy's savers are content to continue funding their country (that famous "home bias") Italy will not be so vulnerable to pressure from external investors.




In fact the Greek external balance has deteriorated rapidly from 1997 onwards, with the current account deficit reaching 14% of GDP in 2007, declining slightly to 12.75% of GDP in 2008. The principal culprit was the growing deficit in the trade balance, which rose to 17% of GDP in 2008 (almost 4 percentage points over the level in 1997). In particular goods exports were disappointingly weak, while import growth was strong, in line with buoyant domestic demand. Trade in services, on the other hand, went in the opposite direction. The balance of services exports improved, attaining a surplus of more than 8% of GDP in 2008, 2 percentage points higher than in 1997. However, this improvement fell far short of compensating for the deterioration in the goods trade balance.

So let us be clear. It is this situation Greece has to correct. Greek society needs to lower the level of national indetedness, and the only way to do this is through an export surplus. But obtaining an export surplus implies the restoration of competitiveness to Greek industry. Greece needs to implement a significant internal devaluation, without this correcting the fiscal deficit will only involve playing around with the tip of the iceberg, and default in the longer term will become inevitable.

The Velocity Of Modern Financial Crises

Jean-Claude Trichet, European Central Bank president, noted when speaking in Cambridge last Thurdsay that the speed at which financial disruption can spread had “accelerated tremendously over the past few decades”. While debt crises in the 1980s occurred over years, the effects of the Lehman collapse “spread around the world in the course of half-days”.

As Ralph Atkins pointed out, the Greek government is but the latest to learn that in the modern world you can be catapulted from relative obscurity to global prominence in a matter of hours. Everyone can be famous for five minutes, as Andy Warhol said, but this kind of fame most of us could well live without.

Faced with the assessment by Ratings Agency Standard and Poor's that Spain's economic and financial situation was deteriorating, the Spanish Prime Minister Jose Luis Rodriguez Zapatero simply limited himself to an outright rejection of such negative economic forecasts, declaring the naysayers to be wrong in the light of the -to him - self-evident fact that Spain was just about, at this very moment, to emerge from the recession which has now bedevilled it for so many months. Indeed he even went as far as to say they were wrong, since he he could find no reason why Standard & Poor's should downgrade Spain's long-term sovereign debt rating, "From our perspective there are no reasons for it, firstly because of the strength of the country (and) because the public accounts are solvent," he told the Onda Cero radio station. Standard and Poor's in fact argued that "The downgrade ... reflects our expectations that public finances will suffer in tandem with the expected decline in Spain's growth prospects", a viewpoint with which few external observers would disagree.

Indeed, Spain's representative on the ECB governing council Jose Manuel Gonzalez-Paramo told the Spanish press agency EFE, in an interview widely quoted in Spanish media, that he, himself, found the S&P opinion hard to disagree with: "The ECB is not taking issue with whether Standard & Poor's should cut Spain's rating, but the report that accompanies this warning is hard to deny....I'm convinced that Spanish authorities share this analysis and will do whatever is needed to avoid S&P's negative outlook resulting in a change in rating," he said.

Had Mr Zapatero found it within his repertoire to be able to express similar sentiments I am sure he would have done more to convince the world at large that he is aware of the problem, and is willing to take the necessary action. As it is, he simply leaves the impression that what just happened in Greece will eventually and inevitably happen in Spain, with all the suddenness and lightning-strike velocity M Trichet was warning about. What we seem to be facing is what Gabriel Garcia Marquez once called the Chronicle of a Death Foretold.

So what do the rest of us do, simply sit back and watch that "accident waiting to happen" actually happen? Angela Merkel may have other thoughts, since speaking in Bonn last Thursday she indicated that she, at least, was of the opinion pressure could be brought to bear on the national parliaments of countries with looming budgetary difficulties.

"If, for example, there are problems with the Stability and Growth Pact in one country and it can only be solved by having social reforms carried out in this country, then of course the question arises, what influence does Europe have on national parliaments to see to it that Europe is not stopped.....This is going to be a very difficult task because of course national parliaments certainly don't wish to be told what to do. We must be aware of such problems in the next few years."

Well, if such pressure can be brought it most certainly now should be. And not over the next few years, but rather, if M Trichet is to be believed, during the coming weeks and months. Lightning may well not strike twice in the same place, but it most certainly can strike twice.

A New Version of the Weak Euro Meme

Well, having been so lavishing in my praise of Ralph Atkins in recent posts, perhaps it is time for the administration of a gentle "rapapolvo" (otherwise, you know Ralph, people might start to talk), and just to hand he offers me the ideal opportunity to "discrepar". A little instability is, it appears, a dangerous thing, but not, it seems entirely and unequivocally dangerous:

True, Greece’s plight has weakened the euro, which has ended this week back down at levels last seen in early November. A weaker euro, however, will help boost eurozone growth - and thus come as a relief to eurozone policymakers. A little instability is not necessarily all bad.

Now, with all the other pressing topics I currently have on my plate I would normally have quietly passed this one by, had it not been for the fact that earlier in the week, over at the Economist, they came up with a similar "saving grace" for a partial Greek default.

How badly the euro’s standing would be hurt by a default would depend on the state of public finances elsewhere: if America were struggling too, the dollar might not seem an attractive bolthole. If the current struggles with a strong euro are any guide, euro members might even half welcome a tarnished currency.

I can think of a thousand and one different ways in which the euro might lose some of its current strong value, I can even imagine a goodly number of those which might be decidedly positive, but what I can't for the life of me accept is that one of them would be the sort of economic, financial and political chaos which we may now be about to see in Greece.